New Species of Exchange Traded Funds Awaiting US Regulatory Approval

By Alexander, Jan; McCrary, Ernest S. | Global Finance, March 2002 | Go to article overview

New Species of Exchange Traded Funds Awaiting US Regulatory Approval


Alexander, Jan, McCrary, Ernest S., Global Finance


EXCHANGE TRADE FUNDS

Exchange Traded Funds are becoming increasingly popular among institutional and individual investors who like their hedging properties, tax advantages, and cost savings when compared to other fund investments. * By Jan Alexander and Ernest S. McCrary

Can any mutual fund become an exchange traded fund (ETF)? Since the Securities and Exchange Commission (SEC) put out a concept release last November to generate comment on the viability of actively managed ETFs, the debate within the industry has turned from whether to broaden the FIT category to how it can be done and still comply with US laws designed to protect the investor.

Institutional investors and hedge funds use ETs as a low-cost alternative to stocks and options. Nevertheless, retail investors get a fair deal because the intraday trading keeps share prices in line with their net asset value (NAV), resulting in very tight spreads, as opposed to the wider spreads that occur in traditional mutual funds.These can be bought and sold only at the end of the trading day, unlike ETFs.

"Investors are beginning to see the power of these tools," says Bill Miller, executive director in the institutional equities division of Morgan Stanley. "We're still in the first inning of this game."

Sponsoring firms have been aggressive in promoting and marketing the many benefits of FITs, especially Barclays Global Investments (BGI), which has created alternatives in just about every investment category and is the world's leading sponsor by number of funds, with 104 ETFs worth $21.6 billion. The largest sponsors in terms of assets under management are State Street Global Advisors, with $41.4 billion, followed by Bank of New York with $32.4 billion.

"The next innovation will be the trading of fixed-income ETFs," says Lee Kranefuss, CEO of iShares, the ETF division of Barclays Global Investors. "We're awaiting SEC approval of ETFs based on government and corporate bonds with the whole curve blend of short, medium, and long maturities." Nuveen also has filed for SEC approval of fixed-income ETs.

Globally, ETF assets have grown by about 43% last year, with assets now above $108 billion, according to figures from State Street. New York Stock Exchange statistics show that the average daily volume of ETF trading in the United States-including Merrill Lynch HOLDRS, which are set baskets of sector stocks instead of actual index funds-rose 219% from September 2000 to the end of 2001, from about 30 million shares traded a day to 100 million.

Even in the United States, where about half of all existing funds are based, the market for ETs is not saturated. Approximately 25% of all equity is in the United States, says Joe Keenan, global product manager for ETFs at the Bank of New York, which leaves much room to grow. In France the figure is closer to 3%, which leaves even more room. Investment product managers all over the world are busy dreaming up new ETF products.

The New York Stock Exchange began trading ETFs in December 2000; previously US funds had been traded only on the American Stock Exchange. Says Cliff Weber, senior vice president of new product development at the American Stock Exchange, "The world has become comfortable with ETFs, but it will bring us to a new universe as fixed-income and actively traded products enter the market. For now, the market is still mostly based on domestic US equities!

Fee Revenue Could Reach $60m

Electronic communication networks (ECNs) such as Archipelago also are part of the game as ETF trading platforms. For Chicago-- based Archipelago, the involvement will increase as it acquires full exchange status by virtue of its acquisition of the Pacific Stock Exchange. …

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